Trend Following: How Great Traders Make Millions in Up or Down Markets, New Expanded Edition

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How did John W. Henry quietly become rich enough to buy the Boston Red Sox? How have traders like Keith Campbell, Bill Dunn, Jerry Parker, and Salem Abraham consistently generated immense wealth in bull and bear markets? The key is trend following-- the only strategy proven to consistently make money. Michael Covel reveals the "underground" network of little-known traders and hedge fund managers who've been following trend for decades. He introduces its fundamental concepts and techniques, showing why market prices contain all the information investors need, and how to understand price movements well enough to profit from them. Using 100 pages of easy-to-understand charts from top trend followers, Covel proves the strategy works -- and shows why only a technical system based on following price trends can win over the long term. Covel presents more than a decade's worth of data: even more backtested trend following results. Covel thoroughly debunks misinformation and failed advice. This timely book capitalizes on today's intense volatility and uncertainty to give investors what they're desperately searching for: a strategy that really works.

Foreword

xi

Preface

xv

Acknowledgments

xix

Part I

1

(84)

Trend Following

3

(22)

The Market

3

(1)

Winning and Losing

4

(1)

Investor v. Trader: How Do You See the World?

5

(1)

Fundamental v. Technical: What Kind of Trader Are You?

6

(4)

Discretionary v. Mechanical: How Do You Decide?

10

(2)

Timeless

12

(3)

Has Trend Following Changed?

15

(1)

Trend Following Modus Operandi: Follow Price

16

(1)

Follow the Trend

17

(5)

Handling Losses

22

(1)

Conclusion

22

(3)

Great Trend Followers

25

(60)

Bill Dunn

27

(14)

John W. Henry

41

(13)

Ed Seykota

54

(9)

Keith Campbell

63

(4)

Jerry Parker

67

(3)

Salem Abraham: Texas Pioneer

70

(3)

Richard Dennis

73

(4)

Richard Donchian

77

(4)

Jesse Livermore and Dickson Watts

81

(4)

Part II

85

(76)

Performance Data

87

(22)

Absolute Returns

88

(1)

Fear of Volatility; Confusion with Risk

89

(6)

Drawdowns

95

(5)

Correlation

100

(3)

The Zero-Sum Nature of the Markets

103

(1)

George Soros Refutes Zero-Sum

104

(5)

Big Events in Trend Following

109

(42)

Event #1: Stock Market Bubble

112

(12)

Event #2: Long Term Capital Management Collapse

124

(12)

Event #3: Asian Contagion and Victor Niederhoffer

136

(4)

Event #4: Barings Bank Meltdown

140

(3)

Event #5: Metallgesellschaft

143

(3)

Final Thoughts

146

(3)

The Coming Storm

149

(2)

Baseball: Thinking Outside the Batter's Box

151

(10)

The Home Run

152

(3)

Moneyball and Billy Beane

155

(1)

John W. Henry Enters the Game

156

(2)

Red Sox 2003--2004

158

(3)

Part III

161

(52)

Human Behavior

163

(16)

Prospect Theory

164

(5)

Emotional Intelligence: Daniel Goleman

169

(2)

Charles Faulkner

171

(1)

Ed Seykota's Trading Tribe

172

(2)

Curiosity Is the Answer, Not Degrees

174

(2)

Commitment to Habitual Success

176

(3)

Decision-Making

179

(10)

Occam's Razor

180

(1)

Fast and Frugal Decision-Making

181

(3)

The Innovator's Dilemma

184

(1)

Process v. Outcome

185

(4)

Science of Trading

189

(10)

Critical Thinking

190

(2)

Chaos Theory: Linear v. Nonlinear

192

(4)

Compounding

196

(3)

Holy Grails

199

(14)

Buy-and-Hold

200

(2)

The King of Buy-and-Hold: Warren Buffett

202

(2)

Losers Average Losers

204

(2)

Crash and Panic: Retirement Plans

206

(3)

Wall Street: Analysis Paralysis

209

(2)

Final Thoughts

211

(2)

Part IV

213

(34)

Trading Systems

215

(26)

Risk, Reward, and Uncertainty

216

(4)

The Five Questions for a Trading System

220

(12)

Your Trading System

232

(1)

Frequently Asked Questions

232

(9)

Conclusion

241

(6)

Slow Acceptance

242

(1)

Blame Game

243

(1)

Understand the Game

244

(1)

Decreasing Leverage; Decrease Return

245

(1)

Fortune Favors the Bold

246

(1)

Afterword

247

(132)

Market Wizard Larry Hite

248

(2)

Inefficient Markets

250

(2)

Trend Following Confusion Reigns

252

(3)

Hedge Fund Hype

255

(2)

Final Thoughts

257

(2)

Appendices

Introduction to Appendices

259

(120)

A. Fidelity Wealth-Lab Pro™

261

(38)

B. Performance Guide

299

(56)

C. Short-Term Trading

355

(2)

D. Personality Traits of Successful Traders

357

(4)

E. Trend Following Models

361

(4)

F. Trading System Example from Trading Recipes

365

(8)

G. Modern Portfolio Theory and Managed Futures

373

(4)

H. Critical Questions for Trading Systems

377

(2)

Resources

379

(2)

Endnotes

381

(24)

Bibliography

405

(8)

About the Author

413

(2)

Index

415

Preface Preface "Men wanted for hazardous Journey. Small wages. Bitter cold. Long months of complete darkness. Constant danger. Safe return doubtful. Honor and recognition in case of success." 1 This book is the result of an eight-year "hazardous journey" for the truth about Trend Following. It fills a void in a marketplace inundated with books about finance and trading but lacking any resource or, for that matter, practically any reference to what we believe is the best strategy to consistently make money in the markets. That strategy is known asTrend Following: "Let's break down the term 'Trend Following' into its components. The first part is 'trend.' Every trader needs a trend to make money. If you think about it, no matter what the technique, if there is not a trend after you buy, then you will not be able to sell at higher prices . . . 'Following' is the next part of the term. We use this word because trend followers always wait for the trend to shift first, then 'follow' it." 2 When it is a question of money, everyone is of the same religion. Voltaire Trend Following seeks to capture the majority of a trend, up or down, for profit. It trades for profits in the major asset classes--stocks, bonds, currencies, and commodities. However simple the basic concepts about Trend Following are, they have been widely misunderstood. Our desire to correct this state of affairs is what, in part, launched our research. We wanted to be as objective as possible, so we based our writing on the available data: Trend followers' month-by-month performance histories. Trend followers' published words and comments over the last 30 years. News accounts of financial disasters. News accounts of the losers in those financial disasters. Charts of markets traded by trend followers. Charts of markets traded by losers in the financial disasters. Education rears disciples, imitators, and routinists, not pioneers of new ideas and creative geniuses. The schools are not nurseries of progress and improvement, but conservatories of tradition and unvarying modes of thought. Ludwig von Mises If we could have developed a book comprised of only numbers, charts, and graphs of Trend Following performance data, we would have. However, without any explanation, few readers would have appreciated all of the ramifications of what the data showed. Therefore our approach to writingTrend Followingbecame similar to the one Jim Collins describes inGood to Great, in which a team of researchers generated questions, accumulated data in their open-ended search for answers, and then energetically debated it. Trend followers we studied form a sort of underground network of relatively unknown traders who, except for an occasional article, the mainstream press has virtually ignored. What we have attempted to do is lift the veil, for the first time, on who these enormously successful traders are, how they trade, and what is to be learned from their approach to trading that we might apply to our own portfolios. Trend Followingchallenges much of the conventional wisdom about successful trading. We were determined to avoid being influenced by knowledge institutionalized and defined by Wall Street. We were adamant about fighting "flat earth" thinking. Durin